Philip Morris International Inc

Good day and welcome to the Philip Morris International third quarter 2020 earnings conference call. Today's call is scheduled to last about one hour, including remarks by Philip Morris International Management and the question and answer session. In order to ask a question, please press the star key followed by the number one on your touchtone phone at any time. Media representatives on the call will also be invited to ask questions at the conclusion of questions from the investment community. I will now turn the call over to Mr. Nick Rowley, Vice President of Investor Relations and Financial Communications. Please go ahead, sir.

Welcome, and thank you for joining us. Earlier today, we issued a press release containing detailed information on our 2020 third quarter results. You may access the release on www.pmi.com or the PMI Investor Relations app. A glossary of terms, including the definition for reduced-risk products, or RRPs, as well as adjustments, other calculations and reconciliations for the most directly comparable U.S. gap measures and additional heated tobacco unit market data, are at the end of today's webcast slides, which are also posted on the website. Unless otherwise stated, all references to ICOS are to our ICOS Heat Not Burn product. Comparisons presented on a like-for-like basis reflect pro forma 2019 results, which have been adjusted for the deconsolidation of our Canadian subsidiary, Rothman, Benson & Hedges, Inc., effective March 22, 2019. Please also note that growth rates presented on an organic basis for consolidated financial results reflect currency-neutral underlying results and like-for-like comparisons were applicable. Today's remarks contain forward-looking statements and projections of future results. I direct your attention to the forward-looking and cautionary statements disclosure in today's presentation and press release, or review the various factors that could cause actual results to differ materially from projections or forward-looking statements. Please also note the additional forward-looking and cautionary statements related to COVID-19. It's now my pleasure to introduce Emmanuel Balbeau, our Chief Financial Officer.

Emmanuel. Thank you, Nick, and welcome, ladies and gentlemen. I hope everyone listening to the call and those close to you are safe and well. Our business delivered an even better than expected performance in the third quarter, despite the ongoing circumstances of the pandemic. Thank you. Most importantly, the excellent momentum of IQOS continues. HTU volumes have grown 28% year-to-date, with a positive mixed effect on our net revenues, where ROPs again made up almost one quarter of our business in Q3. IQOS user acquisition outpaced the prior year quarter to reach an estimated total of 16.4 million users at the end of September. While still below pre-pandemic levels in most places, our combustible business recorded an improved sequential performance. Underlying industry volumes were better across both developed and emerging markets, reflecting increased consumption occasions. This was notably the case in markets with a significant proportion of daily wage workers like Indonesia, Mexico, and the Philippines. Despite these better industry volumes, Indonesia remains challenging, together with duty-free. We must also retain a degree of caution around a second wave of the pandemic and its overall economic consequences across all of our markets. Our operating margins were again significantly ahead in the quarter and on a year-to-date basis, despite the challenges in our duty-free business. This reflects the increasing weight and profitability of ROPs and cost efficiencies. Our cash generation was also strong, with $3.6 billion of operating cash flow in the quarter, putting us on track to reach our target of at least $9 billion this year. Turning to the headline numbers, our Q3 net revenue declined by 1.5%, on an organic basis, marking a significant improvement from the decline of almost 10% in Q2. While this was somewhat aided by certain timing factors, including the revaluation of distributor inventory in Japan ahead of the October price increase, it nonetheless reflects the continued strength of ICOs combined with a sequential improvement in our combustible business. Indeed, The positive effect of the shift in our sales mixed towards RRPs can be seen in the 6.5% organic increase in net revenue per unit. Combustible tobacco pricing was 2.1% up, reflecting solid pricing in a number of markets, partially offset by timing differences with the prior year, a strong prior year comparison in Turkey and headwinds in Indonesia. These timing differences include the effect of delayed pricing in some instances, such as the Philippines, where we took a price increase this month rather than August in 2019. Given this net revenue decline, we were pleased to deliver such a strong adjusted operating income margin expansion of over 300 basis points on an organic basis. I will cover this in more detail shortly. noting that we saw a further benefit versus our prior expectation from additional cost efficiencies and some delayed spending in the last months of the quarter. Adjusted diluted EPS of $1.42 increased by 5.6% excluding currency, better than our prior expectation of a flat organic development. The primary driver was the above-cost benefit, as well as better industry volumes in Indonesia and the EU region, where increased mobility coincided with a reopening of hospitality settings and warm weather. I also want to reflect on our strong performance over the first nine months of the year. This was clearly a challenging period with disruption to many aspects of our operations, including our supply chain and route to market. our net revenue declined by only 0.9% on an organic basis, an exceptionally resilient performance given these unprecedented headwinds. We estimate that duty-free and Indonesia alone were a mid-single-digit drag on our top-line growth. Despite these factors, we saw very good organic progression in our net revenue per unit from the increasing weight of RRPs and solid pricing in combustibles. Our adjusted operating income margin increased by 260 basis points to deliver 7.4% adjusted diluted EPS growth, all on an organic basis. Let me now go into the driver of our Q3 margin expansion in more detail, starting with gross margin, which expanded by 180 basis points on an organic basis. This is driven by multiple levers. Our ongoing transformation is delivering an increasing mix of RRPs in our business. Second is pricing on combustible. Third is our focus on overall manufacturing productivity, where our focus on efficiency, quality, and footprint more than offset the impact of lower combustible volumes. The positive gross margin development was augmented by our focus on SG&A efficiency and with our total marketing, administration, and research costs 140 basis points lower as a percentage of net revenues on an organic basis. This reflects the ongoing digitalization and simplification of our business processes, including our ERP commercial engine, and more efficient ways of working. There was also a benefit from the timing of certain costs, as I already mentioned. Despite the challenges of 2020, we are today raising our expected full-year adjusted deleted EPS range to between $5.05 and $5.10, reflecting around 5% to 6% organic growth. This excludes and assumes unfavorable currency impact at prevailing exchange rate of $0.32. As stated in our earnings release, we have also updated certain guidance assumptions. We now expect a total industry decline of 7% to 8%, and a like-for-like decline in total PMI shipment volume of 8% to 9%, both of which factor in the better Q3 development in the EU and a smaller expected market decline in Indonesia. We assume an organic expansion in our adjusted OI margin of around 200 basis points, also reflecting the above factors and ongoing cost efficiencies. We expect capital expenditure of approximately $0.6 billion and an effective tax rate excluding discrete items of 22% to 23%. We also assume no recurrence of national lockdowns in our key international market in the fourth quarter and remain vigilant with regard to the pandemic as economic uncertainty remains and localized social restrictions are being tightened in some geographies. Focusing now on the fourth quarter, we assume underlying consumption trends should be broadly stable versus a robust Q3. In many markets, including the EU region and Russia, increased consumer mobility, the opening of hospitality settings and summer conditions provided a helpful backdrop to our performance. However, there remains continued pandemic-related uncertainty as we now see localized restriction tightening in certain countries, with potential impact on both mobility and economic vitality. The delay of certain SG&A costs from Q3 will also have an impact on our fourth quarter results. In addition, it's worth noting that while the price increase in Japan took effect on the 1st of October. The majority of the impact this year was realized in the third quarter through the revaluation of distributor inventories. I should remind you that Q4 2019 presents a strong base of comparisons. This is notably due to pricing in Indonesia ahead of the January 2020 excise tax increase and an exceptional Share gain in Saudi Arabia due to market disruption ahead of new plain packaging requirement. As such, while we expect around 5% to 6% organic EPS growth for the year, we expect the organic progression to be flat to modestly negative in the fourth quarter, excluding 4 cents of estimated unfavorable currency. I will now cover our third quarter performance in more detail. As with net revenues, our combustible shipment volume sequentially improved, albeit the year-over-year decline remains greater than historic average. This was supported by better industry trends in all regions. Conversely, our HTU shipment volume continued to grow strongly to reach a record 19 billion units driven by the EU region, Japan, and Russia. I also want to touch on the year-on-year inventory movement in the quarter, which negatively impacted our shipment on both cigarettes and HTUs vis-à-vis consumer offtake. The reversal of trade builds up in H1 in markets like Germany and Russia was one contributing factor. Specifically for Japan, there were reductions in distributor inventory in Q3, following increases in both Q1 and Q2 of this year in anticipation of retail and consumer loading before the October tax-driven price increase. As such, our shipments in the quarter were less than our in-market sales volume. Importantly, inventory for cigarettes and HTUs in Japan are now aligned to the expected market size following the price increase. The main positive impact of the price increase on our Q3 results was the revaluation of distributor inventory. This strong performance from ICOS means that heated tobacco unit made up over 10% of our total shipment volume in the first nine months of the year as compared to approximately 8% in 2019 and 5% in 2018. We continue to expect this proportion to grow over time as the positive momentum on RRPs continues and remain well on track to achieve our target of 90 to 100 billion units in 2021. Our mission is to grow the RRP category globally and transform the mix of our business. With $4.9 billion in sales year to date, RRPs are now approaching one quarter of our total net revenues. Indeed, While this percentage was just over 23% in the quarter, if we were to adjust for inventory movements, Q3 would have almost reached 25%. IQOS devices accounted for approximately 8% of RRP net revenue year-to-date, mainly due to a naturally lower ratio of new users to existing users, longer replacement cycle and geographic mix, particularly in the third quarter. In some geographies, we still sell a substantial amount of the lower-priced original ICOS 2.4 Plus device, and we have now introduced LIL Solid in Eastern Europe. The East Asia and Australia region provides an illustration of RRPs operating at scale and is on track to deliver over half its revenue from RRPs this year. While the investment phase of building commercial infrastructure can weigh on margin as scale is built, the strong margin expansion over recent years show how powerful scale and experience in R&P can be as investments start to pay back and the commercial approach is optimized. Focusing now on our total international market share, the developments were very positive for the bulk of our business. Before the impact of duty-free cigarettes and Indonesia, our share increased by 0.4 points. This was driven by higher share for heated tobacco units, which increased by 0.8 points to reach 3.1%, only partly offset by lower share for cigarettes. In markets where ICOS has a meaningful presence, our share increased with few exceptions. It followed that our combined market share increased in the EU region, Japan and Russia. However, our total international market share was negatively impacted by duty-free, where our share is higher than the PMI average, resulting in only partial recapture of volume in other markets, and by Indonesia, which I will come back to separately. It is also true that in many markets, Malboro over-indexes to social consumption occasion, which are naturally lower during COVID-related restrictions. While the easing of measures in uneven across-market, we saw aggregate malborrowed shares start to recover sequentially in the quarter. I turn now to Indonesia. While the challenges related to the excise tax structure remain, underlying consumer trends improve in the quarter. Industry volumes declined by 6%, excluding trade inventory movements, a notable improvement from the 22% decline in Q2. This primarily reflects a recovery in daily consumption from depressed levels as confinement eased. Given the continued rise in COVID cases and the possibility of more localized restrictions, such as those temporarily introduced in Jakarta last month, we do not assume significant further improvement in the fourth quarter. However, reflecting the better third quarter industry volume and exit rate, we now expect the total industry decline on a shipment basis to be around 11% for the full year versus 15% previously. While the smaller industry decline has a commensurate effect on our volumes, our market share remains under pressure despite improved performance from the higher margin AMILD, GSamsu Magnum and SKT brands. This is due to the same dynamic mentioned last quarter. Most notably, the growth of tax advantage below Tier 1 brands continues as tax-driven pricing and the pandemic have increased downtrading. To illustrate this issue, the tax per stick on our Tier 1 Emile brand is more than 60% higher than on a comparable Tier 2 Cretec brand, with a similar resulting difference in the retail selling price. With the segment now at 26% of the market, this represents a serious and growing threat to state excise revenue and a diminished return on this year's tax increase. The correction of volume-based tax tiers remains urgent. We are hopeful that the government will take steps over time to ensure more predictability in tax revenue and a level playing field by reforming the multi-tier excise structure. The process of minimum selling price implementation also continues to progress slowly, hampered by the pandemic. Full enforcement may not be complete until the end of the year at the earliest. I move now to our RP performance. We estimate that there were 16.4 million total ICOS users as of September 30th. This represents the addition of around 1.1 million adult users since the end of the second quarter and over 4 million since the same time last year, with more users added in both Q3 and year-to-date than the corresponding period in 2019. This is an exceptional achievement given the circumstances where our accelerated pivot to digital and remote engagement is paying dividends. We further estimate that 72% of this total, or 11.7 million adult smokers, have stopped smoking and switched to high-cost with a balance in various stages of conversion. This again reflects widespread user growth momentum across all key high-cost geographies, including Japan, the EU region, and Russia. As our user base expands in markets like Japan and Russia, we are increasingly enriching our offer and segmenting the market with new products and more price points. We plan to bring more exciting innovations from ICOS in the coming quarters. We are also optimistic that the FDA's granting of modified risk tobacco products reduces exposure orders for a version of ICOS, will contribute over time to better understanding of the heated tobacco category and the benefit of switching to ICOS compared to continued smoking. The success of ICOS in global key cities, where our commercial strategy typically has a strong initial focus, serve as a useful indicator for national share growth potential. In many such cities across a wide range of market, Our share is now well into double-digit and still growing. This provides an excellent base from which to further grow our R&P business as we innovate and broaden the ICOS offer. In the EU region, we added a further 0.4 million ICOS users in the third quarter to reach 4.7 million, a continuation of a recent increase. strong performance, while most adult menthol smokers have switched to non-menthol cigarettes since the ban in May. We have seen some incremental switching to ROP over the May-September period and continue to see further opportunity to convert these consumers. Third quarter share for Eats reached 3.9% of total cigarette and HTU industry volume. This was in line with Q2 2020, but sequentially increased by 0.1 point when adjusted for estimated retailer inventory movements and consumer pantry loading effect. Sequential IMS growth also on an adjusted basis was plus 16%. This reflects strong absolute growth in Italy and Poland. It also includes further progress in Spain, and in the UK, where both national and London of tech shares continued to grow, with the latter exceeding 3% in September. I also refer you to the appendix where we show shares for key EU markets. ICOS continued its strong performance in Russia, with our HTU share up by 1.8 points to reach 5.8%. On a sequential basis versus the second quarter of 2020, share decreased by 0.2 points, reflecting a cigarette market which grew 6% on the same basis, aided by seasonality of consumption and lower illicit prevalence. Sequential HTU in market sales adjusted for trade inventory movement increased by more than 9%. With the introduction of heat creation in Q1 2020, and fit consumable for Lil Solid this quarter, we now have a price-tier portfolio to cater to a broader range of adult smokers across the socio-economic spectrum. In Japan, our total reported share for heated tobacco unit reached 20.5% in the third quarter, supported by line extension for both Marlboro Heat Stick and Heats, such as the recent launch of Marlboro Black Menthol. ICOS users grew to an estimated total of 6 million, of which an estimated 4.4 million have stopped smoking and switched to ICOS. On a total tobacco basis, including cigarillos and adjusted for trade inventory movement, the share for our HTU brands increased by 2.6 points versus the prior year quarter and by 0.2 points sequentially to 18.9%. Q3 2020 adjusted in-market sales volume for our HTU brands grew 7.3% sequentially. The overall heated tobacco category continues to grow with a large majority of this growth driven by ICOS and now makes up almost 26% of the total tobacco market. In addition to a strong growth in existing market, the geographic expansion of ICOS continues. We leverage our digital capabilities to launch in four new emerging markets, Costa Rica, Georgia, Jordan, and the Philippines. This takes the total number of markets where ICOS is available for sale to 61, of which over half are outside the OECD. The launch in the Philippines was initiated digitally before adding retail touchpoints and is focused on Metro Manila, where consumer purchasing power is higher. While the geographic scope is limited, we are encouraged by progress so far. We have also now started the commercialization of ICOS-V, our new eVapor product, which was launched in New Zealand during the quarter. Initial adult consumer feedback is positive, and we plan to roll out to further market in Q4 and 2021. The commercial infrastructure of ICOS will allow us to deploy efficiently and at scale. we place great importance on guarding against youth access for all our products. In this category in particular, we will be testing age verification technology in select markets. As part of our mission to build and accelerate the global RP category, we aim to offer a choice of experiences, formats, and price points to adult smokers and consumers of other nicotine products. Our collaboration with KT&G is consistent with this goal, as demonstrated by the first launches of LIL product through our ICOS infrastructure. We introduced the LIL solid heat-not-burn device and fit HTUs in both Russia and Ukraine during the quarter. As we reach shares approaching 15% to 20% with ICOS in key cities such as Moscow and Kiev, and we expand to areas with lower purchasing power, A simple, affordable proposition can play an important complementary role in reaching more adult consumers and maintaining a strong rate of user acquisition. Early results are encouraging with positive feedback from adult users. This means that in both these markets, we now have HTU brands at three price points within the heat-not-burn category. Super premium heats creation dimension. Premium heats. and mid-price fit, all of which present attractive margin. We will also shortly be launching the LIL hybrid device, mixed consumable and nicotine-free liquid cartridge in two Japanese prefectures, offering adult consumer a differentiated premium experience, which combines the satisfaction and rich flavor of heated tobacco with added sensorial element. There is a consumer segment in Japan looking for such an experience, and we believe this will be the best hybrid product available in the market. I want now to emphasize the deep alignment of our business with sustainability and ESG objectives, which sit at the core of our mission and strategy. Our most important ESG issue is the health impact of our product. By innovating with significantly better alternatives such as ICOs, we have a historic opportunity to substantially reduce this impact by switching adult smokers, who would otherwise continue to smoke, to reduce risk products. Through deploying ROPs at scale, we can improve public health and contribute to the Sustainable Development Goals, especially Goal 3, good health and well-being. We also have best-in-class practices across a range of central ESG issues, where the other three of our four sustainability pillars are focused. We believe this provides a unique combination whereby sustainability is a true driver of innovation and growth. By embedding sustainability into the core of our business, we can create value for our shareholders and society at large. To conclude, our Q3 results were stronger than expected and we have raised our full year guidance to reflect around plus 5 to plus 6% organic EPS growth. We are building a business through RRPs to deliver superior and sustainable growth over the coming years. The continued momentum of ICOS through the challenges of the pandemic demonstrate this structural growth characteristic. We are also committed to maintaining the competitiveness of our combustible business. We have a number of levers for growth in our top and bottom line. First, the powerful mixed effect of RRPs. Second, pricing which will remain important for combustible and where appropriate for RRPs. Efficiency in our manufacturing and SG&A costs are further levers as we continue to hone our business model. Moreover, with the launches of the ICOS VIVE and LIL product, we are broadening and stepping up our product offer and innovation in 2021. You can also expect us to bring further exciting innovation to our ICOS heat node bump platform. As I just mentioned, Sustainability and ESG are at the heart of our smoke-free strategy, and we continue to work tirelessly to further our mission. As we all know, there remains continued uncertainty regarding the pandemic, the impact of social restrictions and their economic aftermath. However, when COVID-related headwinds abate, we expect to resume growth consistent with the currency-neutral compound annual growth rate in our 2019-2021 algorithm of at least 5% net revenue growth and at least 8% adjusted diluted EPS growth on an organic basis. In short, we look forward with confidence and we will expand on these topics further at our next investor day, which we plan to hold in early 2021. Thank you. I'm now more than happy to answer your questions.

Thank you. We will now conduct the question and answer portion of the conference. Again, in order to ask a question or make a comment, please press the star key followed by 1 on your touchtone phone. In the interest of fairness and time, We ask that participants keep to a maximum of two questions each. If time allows, follow-up questions may be taken. You may rejoin the queue again by pressing star, then the number one on your touch-tone phone. Our first question comes from Adam Spielen of Citi.

Hello. Thank you very much. So, my first question is, You reiterated that you're very, very comfortable with the $90 to $100 billion target for 2021 for RRPs. Are you still comfortable that you will exceed $250 billion in 2025, which is your other longer-term target? That's my first question. Thank you.

Thanks, Adam. We definitely are repeating our ambition to reach next year 20, 200 billion stick in the eat not burn category. And I think that the growth that we deliver quarter after quarter is clearly pointing to that direction. Then you are alluding to the 2025 objective of 250 billion plus, which is, I think, here aligned with what I've started to detail on the presentation, which is really the fact that we are broadening the portfolio when it comes to ROP's product. And we are going to, of course, come with more enrichment, more segmentation, more offering when it comes to heat not burn, we are entering the e-vaping category, and all that is going to put us on the track to deliver that ambition. And I think everything I've been saying in terms of segmentation of the devices, now that we are coming with the little offering, what we have started to do now in Japan, in Russia, when it comes to the consumables. It shows that we are clearly now that the market is getting a bit more mature. Of course, it's still at an early stage in most places, but in a few places, we have some first element of a bigger market. It is time now to enrich the offering and broaden the spectrum of what we can offer to I would say, conquer and convince more smokers to switch to our product. And therefore, that is what is going to put us on the right track for this ambition for 2025. Thank you very much.

I don't want to undermine this. I don't want to put words in your mouth. But your market shares in Russia, in Japan, they grew in Q3, but sequentially less than in Q2. And I'm wondering... why that was, do you think, and whether really it's significant or it's just sort of random quality fluctuations and we should just ignore that part.

Yeah, I don't think that there is anything to be read there. I think that we are very happy with the performance on the key market. Of course, you know, what has been, and depending on the season and the consumption pattern and what has been happening on the borders, we know that some borders were closed. We talk about illicit trade being stopped. I mean, that can be disruptors to the evolution if you take a kind of flash or spot quarter view. But I would say the trend that we have seen in Q3, we are very much aligned with a nice, strong trend that we've been observing over the first part of the year, over H1. So I don't think that there is anything in Q3 that would be signaling a slowdown in the way we are gaining share in an underlying manner.

Thank you. Very helpful. Thank you.

Our next question comes from one of Pamela Kaufman of Morgan Stanley.

Hi. Good morning. So there's obviously a lot of ongoing uncertainty, but as you just reiterated, you are on track for your heated tobacco target for 2021. I guess broadly, how are you thinking about how you're positioned for growth next year? And do you anticipate accelerating growth as you lap the performance this year and see benefits from the enforcement of minimum price increases in Indonesia?

Well, thanks for the question. Obviously, it's very early stage to start talking about next year. I think you very rightly said it. 2021 is full of uncertainty, and we even recognize that the last months of 2020 have their fair share of uncertainty as well. So difficult to, of course, start to elaborate on 2021. The only thing I can say at that stage is that we are going to enter 2021 with the strength of our ROP business. That is clear, you know, from this first nine months performance. There will be certainly a number of low comps in the basis of 2020. But as we don't know how the markets are going to be in 2021, and if I take the example of duty-free, which, of course, you could say we're going to have nine months with very, very low business in duty-free in 2020. So one could argue, well, that's an easy basis of comparison. But nobody is able to say today what's going to be the rebound today. next year of duty-free. So it's just difficult to say which kind of growth trajectory at that stage it designed, if you want. I hope we'll know more at the beginning of 2021 when we will comment on our full year 2020, and at that stage we can share a more detailed view. But I think that for us, the main element today that I would say is kind of for sure, whatever is the environment, is a very, very strong performance of our Eat Not Burn business.

Thank you. And also, obviously, very strong margin performance in the quarter. Can you elaborate on the factors that contributed to that in terms of lower marketing and administrative costs? You pointed out manufacturing efficiencies. How are your customer acquisition costs trending and how much of the lower cost is temporary versus sustainable going forward?

Sure, happy to do that. Well, the margin improvement is, and that's probably the strength of the performance, is not coming from one element. I think it's a collection of drivers that we have to add to the top-line evolution, nice margin evolution. And that is coming first, of course, from the growth of RPEs. And I think we are showing this quarter the impact on the growth margin of the positive impact on the mix of the consumable in It's Not Burn. And as we keep growing the business, that is, of course, a nice mixed positive impact, clearly helping the margin. There is also everything we are doing on price, and we keep clearly working in the direction of improving nicely price on combustible. There is, and I would be happy to elaborate further if you want, then there is, of course, everything we do on manufacturing productivity, which is also a nice driver. And then below the gross profit, you're right, we have this Very positive evolution of our SG&A, where we managed to decrease on an organic basis SG&A by about 7% when the decrease of the top line is only 1.5%. So we have a nice leverage, if you want, between the two. And here you have a mix of things. First of all, yes, of course, we are working on the efficiency of our cost. So all functions, all teams are working on working in a simpler way. more efficient, more digitized manner. We are platforming, you know, our work. We are standardizing. We are automating. We are using digital in all capacity, you know, in order to work in a more efficient manner. So that is contributing to certainly some saving. Then on top of all this effort, you're absolutely right, we have increased efficiency as we turn toward a more digital commercial engine on our piece. And that is, of course, something that is going to accompany us on the long term. You know, we build at the origin the high-cost business with a business model, you know, with a lot of physical coaches and based on, you know, having some retail places that we were owning. And that was great to start. We needed to do that. But, of course, as we are growing the market, as we are learning about it and as we are developing our digital skills, we are indeed developing a tool which is really efficient both in terms of digital customer experience and in terms of digital trade experience. And that is allowing us to be much more efficient in contacting smokers that we can convince to switch to ICOS in explaining and accompanying them on answering all their questions, in coaching them in a digital manner for them to understand how it works, how is a global experience. To answer their question, we have been creating communities where people switching to ICOS can exchange their impressions. and their tips. And then once it is done, of course, the job is not done and we are moving to retention and really build this intimacy through having a lot of data about our customer of ICOS and really being able to bring them the best information overall experience and keep them as a customer of our Eat Not Burn business. So that's what we are doing today, and absolutely that is translating into a reduced cost of acquisition and a reduced cost of retention. We are certainly not at the end of this improvement, but that is nicely helping the performance in 2020 for sure.

Thank you.

Our next question comes from one of Michael Lavery of Piper Sandler.

Good morning. Thank you. You've launched in some markets this year, and certainly it doesn't seem like the easiest of circumstances to really get those going with pandemic closures and restrictions. But you've got some like Saudi Arabia launching. already at 40 basis points of share, obviously small, but France took several years to get to that. Mexico also 20 basis points. It's early, but these look like they're a pretty good start. Can you touch on some of what's driving that? I know you just mentioned some of the digital things. Is that really the key? Are there other factors? What's just getting some of these markets going a little bit more quickly than we've seen in the past?

Well, I think in each market, Michael, is different. So the answer probably could require a long explanation and ensuring the various type of dynamic. And starting with the regulation, of course, you know, the capacity that we have to speak about ICOs and explain how it works. In some markets, we have this capacity to explain to smokers that a better alternative does exist. In other countries, we are much more limited. So that is clearly having an impact. then certainly there is an impact, you know, as you grow the visibility of ICOS, as you are, you know, people starting to see friends, family around them using ICOS. You may have a kind of snowball effect, you know, maybe it's a little bit of a caricature, but I think to some extent it can play like that. and that can accelerate the evolution of a market. You have also the cultural dimension, which is quite important. In some countries, people will be proud of having discovered ICOS, and they will want to share that with their friends, and they will become our best salespeople, I would say, about ICOS and taking themselves the time to explain and convince friends and relatives. In other cultures, it would be very different and that won't happen because they will believe that it's a personal choice and they don't want to interfere on that. So all that to explain the very different pattern that we are seeing in terms of development of the business. Having said that, you're absolutely right. The more we're going to be able to go digital and have great digital tools to contact smokers, talk about ICOS, be able to engage them in what is the ICOS experience, the more we're going to be able to grow the market and clearly, you know, developing the digital customer experience is going to be key, hopefully, in accelerating the growth in several markets. But let's not underestimate the fact that regulation can be a a pretty significant restriction nevertheless, even when it comes to using digital tools. So, again, that explains why I think, you know, there is certainly no market where we're not saying that we have the ambition to make them an R&P market, but certainly in some markets it's going to take a bit more time.

Okay, that's helpful. And then we're about five months into the menthol ban in the EU for cigarettes. You mentioned a little bit of incremental momentum on Icos menthol, especially in a market like Poland. There's been a big share jump there. How much is that related to menthol success, getting cigarette smokers to switch, and how much more runway is there for that to go?

Sure, Michael. What I can share with you is that you remember that menthol was roughly speaking 10% of the EU market altogether. I think the vast majority of the mental smokers have been switching to other type of combustible cigarettes. So I don't think that there has been certainly not maybe what was hoped in terms of people stopping to smoke. It's probably a few percent, but no more than that. And when it comes to switching to other alternatives like Eat Not Burns and ICOS in particular, you know, maybe around 5% of the people have done that so far, which doesn't mean that we are giving up. We think that we can certainly convince more people. But I think the impact has been relatively limited. You're right, probably helping a little bit in Poland, maybe in the UK as well, which, you know, are too big market for people. but I would not say that it has been having a big, big positive impact so far on our ICOS business.

Okay, thank you very much.

Our next question comes from one of Vivian Azar of Callen.

Hi, good morning. I appreciate all the detail around digitization and ICOS user engagement. Seemingly, you know, a lot of the the hard investments you guys made early and then the incremental investments are paying off. I was wondering if we could kind of pull that all together and perhaps quantify the evolution of your ICOS user acquisition costs in particular over the course of 2020 given COVID. Thanks.

Well, I understand the question, but at that stage, you know, I think we're not going to enter into more granularity. I think we are, you know, giving through this set of numbers and presentation more detail on the driver for profitability. So I'm sure that you are able to capture, you know, through the gross margin evolution and other elements that we are giving some elements. But it's obviously, as you can imagine, a relatively... strategic information, sensitive, and therefore it's not something that we can share. But I'm certainly happy to confirm that we are seeing a significant decrease and that we have ambition for more significant decrease in the future. So I'm just reiterating my comment that you should expect more improvement on the ramping up of the profitability of our RP business in the future, which is really great because we are combining a big, big driver for the top-line growth, quite obviously, and in addition, a nice driver for profitability improvement.

Okay, that's fair. Thank you very much. And my second question is just on price gaps in the heat, not burn category. It makes a lot of sense to me. that you would want to introduce a tiered portfolio as your penetration, you know, continues to mature, if you will. How are you thinking about those price gaps relative to combustibles, though? I mean, you've used the same kind of descriptive language in terms of the price segmentation. In Russia, are we meant to take that to understand that you're going to match price gaps against combustibles with a tiered heat-not-burn consumable portfolio, or is there a reason to think it might vary? Thank you.

Well, as you know, globally, we have a position because it deserves it, our RP business as a premium business. It's a unique consumer experience and that fully justifies a premium price positioning. Now, of course, as you know, in some countries as well, the excise duty level is lower, sometimes materially lower on RRPs and on heat not burned than on combustible cigarettes. And therefore, that is also justifying a lower price point. So I would say as a rule, you know, we have our combustibles that are priced at the price on malboro or sometimes, you know, even a bit below malboro. And I think it's a good positioning. The sweet spot really reflects the overall experience and the value for the consumer, but also the specificity of the Eat Not Burn category and our Eat Not Burn product. And in segmentation, we're going to do the same. It's, of course, related to the customer experience as well, and all three consumables are not the same, and they not deliver the same experience. And exactly like we have been doing for decades on consumables, depending on the level of, I would say, benefit, value for the consumer, what he's perceiving, the overall pleasure and positive dimension for him. We'll have different price positioning that will be aligned with that. I don't think we should expect anything really materially different there.

Understood. Thank you very much.

Our next question comes from one of Bonnie Herzog of Goldman Sachs.

All right. Thank you. Hello, Manuel. Hi, your quarter was stronger than expected and you're seeing a better demand environment and then you also took up guidance again. I guess I'd like to get your thoughts on resuming your share buy back program and if this might be realistic next year. It seems like you have flexibility and I guess I think of it as an important positive signal for the market that probably would be viewed favorably. I just think it would probably help to support your stock price. So I'd love to hear what your current thinking is on this.

Thanks for the question, Bonnie. We haven't changed our mind at that stage on the buyback. We've announced, as you know, a 2.6% increase of the dividend to $4.80 a year. So we continue to reward the shareholders. And I think we stated in the past, and we are very much on that line, that we would not start a share buyback that could potentially endanger the rating. And I'm not sure that today we have a huge flexibility on that rating with the balance sheet that we have today. So we have a very strong balance sheet, and we want to keep that. I don't think that we would love to be losing some value some notch in the rating because of buyback. So I'm not closing the door on the long term. Of course, it's a moving situation, and as we keep generating cash and strengthening the balance sheet, we may, together with the board, decide to change that. But for the time being, this is not on the agenda.

Okay. That's helpful. And then I know it's early, but I was hoping to get maybe your thoughts on – what you see as the key tailwinds or maybe headwinds as we look out into 21. You know, I guess as I'm thinking about your business and what you've accomplished during this pandemic, it seems like the setup is quite positive, especially as I think through a few tailwinds, such as, you know, for instance, the one you have in Japan. I'm not asking for guidance for next year, but is there a way that you could just kind of lay out a few of these tailwinds as you see them for your business and or possibly headwinds. Thank you.

Thanks, Bonnie, for not asking for a guidance because I would not do it anyway. Trying to elaborate on tailwinds and headwinds. I think the tailwinds are quite obvious. We have this RP business That is, you know, almost one-fourth of the business, so it's very material in terms of, you know, share of revenue. That is going very strongly. You know, we talk about a growth of about 28%, 29% year-to-date. We see a number of markets that are actually contributing to the dynamism. We are, as we've said, you know, enriching the offer. So we see that we start to enter into new phase of this ambition of creating this category that we think one day would be, I would say, putting an end to a smoking world by this segmentation enrichment of the offer. So we have here a very powerful tailwind that is going to help us as we enter into 2021. And as you have seen, it's not only, as I said, positive for the top line. But it's also nicely positive for the bottom line because we are ramping up the profitability on that business. And that is a business that has the potential to be super nicely profitable. Then, of course, you know, I said it, you have all this. very low combs that we're going to have in few markets. We have this Q2 that has been very difficult. You have the duty-free business that is extremely depressed. So one could argue that if things were to start, you know, gradually in 2021 to be back to normal, that could provide easy comb for growth. Now, that unfortunately is a segue for Edwin's because we don't know what's going to be the environment. More and more people are saying that we're not going to be back to normal maybe until the summer of 2021. Nobody knows what exactly it means, by the way, but people are saying when the vaccine will be available, which could be summer 2021, that's a condition to be back to some more normality. And therefore, we don't know how it's going to play out globally on the business. But I think we are taking comfort and confidence from the fact that I mean, 2020 will not have been a walk in the park, that's for sure. And despite that, we are delivering what I consider to be a robust performance and targeting now a nice organic growth for the adjusted EPS. So it shows that even in a difficult environment, we manage to deliver a nice performance.

All right. Very helpful. Thank you.

Our next question comes from one of Gaurav Jain of Barclays.

Hi. Good morning, Emmanuel. So a couple of questions. One is on the CapEx. So CapEx was again reduced to $600 million, and now it is meaningfully below depreciation, which runs at about $950 million for your company. So is this a new run rate of CapEx, and can your depreciation step down in the future?

Sure, Gaurav. So, no, this is not the new normal for the company. We are obviously, you know, going through stormy waters. So it's an adjustment and there is a number of projects, by the way, that given the environment, you know, we prefer to postpone. So that explains why we are now targeting $0.6 billion for the year. I think you can expect us when we are back to a more normal environment, to be back to a more normal capex amount, that I would say probably to be around 0.8 billion. So that could stay below the level you write of amortization. and depreciation that is north of 900 million today. And, of course, you know, over time, if it continues like that, that will mean that this amount will decrease as well. You're absolutely right. I'm not able to give you a phasing for that, but that should be, over time, a natural evolution. Though, of course, you know, with a carryover effect, it will take some time.

Sure. And my second question is on your travel retail business, where you have booked zero revenues on ICOS in the Middle East and Africa line. And, you know, clearly the market is not down 100%. So you are supplying out of inventory. So is there any risk of inventory write-down in travel retail?

I think at the end of September, we have been taking care of the potential impact of that. So I would not expect anything major for the rest of the year.

Okay, brilliant. Thanks a lot.

Thank you.

Our next question comes from one of Chris Grohe of Stiefel.

Hi, good morning, Emmanuel. I just had a question for you, if I could, on some of the inventory adjustments that occurred in the quarter last And just understand, so Icos had an inventory drag that weighed on its volume in the quarter, and you reported an even stronger performance for that brand, excluding inventory changes. Are inventories, say, for Icos, I guess I'd be curious for your business overall, are they at the right level, or are there expected changes to occur in the fourth quarter on inventory, perhaps a billion inventory? Sure.

No, Chris, I think that you're right, and I think we flagged, you know, in H1 that there was a number of countries with some anticipation on inventory. We got the reversal of that in Q3. You're right, if you retreat the shipment by that, we have a record around 20.5 billion stick of in-market sales, which is, you know, I mean, It's quite a symbolic threshold, but to be able to $20 billion is quite nice. And we believe that we are globally at the right level at the end of September. So, you know, we're not expecting today in Q4 any material impact on inventory for 8-net burn.

Okay. Thank you. And then just a second question on Veve and the kind of – just understand – the degree to which you could undertake a wider scale launch in more markets in the fourth quarter? Are there production limitations? Obviously, I'm sure there are at this point, but just understand how you think about the progression of that launch in more markets in starting the fourth quarter.

So there could be, you know, a very limited number of market launch in Q4. I think we're taking the time to have all the lesson learned from what we've seen in New Zealand to make sure that When we launch, we are super ready and very successful. There are certainly things around edge verification on which we are still working and which are very important for us, as you know. So we are still working on these various dimensions. So don't expect too much in Q4. I think the big new launches will be more for 2021. Okay. Thank you for your time.

Thank you.

Again, ladies and gentlemen, in order to ask a question, simply press star, then the number one on your telephone keypad. Our next question comes from one of Owen Bennett of Jefferies. Afternoon, Emmanuel.

Hope all well. Owen, hi. First question, please. I just wanted to come back to Adams and the $250 billion target by 2025. So you mentioned the role the expansion of the portfolio into eBay will have here. obviously very different economics between heated and vapor. So how do you see that 250 billion being split between the two categories? I know very early days, but I'm kind of a rough idea internally how you see that evolving.

Sure, Owen. So we haven't been splitting the 250, so I won't do it now. I think we believe that quite obviously each RP category has a play in getting there. But there is no doubt that we continue to see the heat-not-burn category as, you know, being, I would say, the majority of these 250. So we certainly intend to develop evaping and Icosviv and, you know, other things that we could launch from now until 2025. But I think you should expect still a big part of this, a big majority of the 250 to come from Remember, I mean, this is an aspiration that we've been sharing. I think as we progress, we'll make sure that, you know, we put more detail around that. So, you know, bear with us. We're going to certainly continue to give. more vision, more visibility. But at that stage, I cannot split further the 250. And quite obviously, we want to develop things in a profitable manner. So that is also drive the choices and the final number in the split of the 250 billion.

Okay, thank you. And second one, I was hoping you could give me the X inventory heated volumes in Eastern Europe for Q1, Q2, and Q3 to just see how that's kind of progressing, stripping the inventory impacts out.

Well, I don't have that with me, but I can see with the team maybe afterward whether there is something that we can find out for you.

Okay, great. Thanks very much. Appreciate it.

Thank you. Thank you.

And thank you. We have reached the allotted time for questions. I'd now like to turn the call back over to management for any additional or closing remarks.

Thank you very much. That concludes our call for today. If you have any follow-up questions, please contact the investor relations team. Thank you again, and have a great day.

Thank you all. Talk to you soon. Bye.

And thank you, ladies and gentlemen. This does conclude today's call. You may now disconnect.